What the loss of Carillion means to the industry and how we can learn from it.January 30, 2018eps_admin
As one of the largest government contractors in the UK, the loss of Carillion will have far-reaching effects. As more details emerge each day, we are currently asking more questions than we are receiving answers.
Public Private Partnerships
To learn from Carillion’s demise, we first need to understand how it happened. Carillion was a construction company primarily, more specifically focused on high value contracts for the Government. PPP (Public-Private Partnership) contracts were introduced by the Government with the aim of reviving Britain’s public services. Conversely, the only thing PPP seems to have done is create bidding wars between contractors fighting for these significant contracts. Since the Government is spending public money, contracts are inevitably price sensitive, leading to decisions being made on cost and awarded to those offering the lowest cost option. This resulted in contractors working on exceptionally low profit margins, often as low as 2%! Companies need contingency to protect against subsequent issues with a contract, and with a 2% profit margin there is no contingency, and as was the case with Carillion, the profit can quickly be wiped out completely, causing huge losses.
Since government contracts are offering such low margins, why do contractors continue to fight for them? The simple answer is, with government contracts large cash payments are made up front, before the work has even started. Large contractors tend to use this money to pay other liabilities to ease their cashflow position. Sub-contractors on their supply chain will be on payment terms and do not need to be paid till a later date. An unprofitable business can continue to survive due to the positive impact on cashflow of upfront payments, with it not being apparent there is such a significant underlying issue. A company is deemed to be insolvent when it cannot meet its liabilities when they fall due. Awarding a government contract provides a cashflow injection which can allow a business to continue to meet its liabilities as they fall due, especially if they are continually being awarded new contracts. It is only when everything unravels that we can see the full impact.
The big sub-contractor names that have been affected by this are Galliford Try and Balfour Beatty who together have lost around £110 Million.
The ripple effects
The ripple effect of those effected by the demise of Carillion are far reaching, from the tens of thousands of direct employees, the 1,400 apprentices, the many subcontractors on the supply chain and their subcontractors.
Carillion have been posting profit warnings for quite a while, which raises another question. Why were they trusted with Government contracts in the first place? The Prime Minister has come under fire for this and her response was “A third of Carillion contracts were administered by the previous Labour Government.” There have been calls for a full-scale investigation to take place into exactly how such a big company could end up in such a mess.
The company will be investigated and it has recently been announced that the directors will also be investigated. There have been allegations that the directors have protected their bonuses rather than paying staff or sub-contractors.
We can conclude that the downfall of Carillion has added weight to the argument that the construction industry model is broken. It is very hard to sustain high quantity with such low margins.
There are so many lessons to be learnt from this fiasco. The Government clearly needs to look at the PPP agreements and also the way sub-contractors are used in Government contracts. Industry insiders have suggested that Carillion is not an isolated case and they have anticipated that other large companies may face similar issues.